In the Nation's Interest

A “New Normal” Where Consumers Don’t Drive the Economy So Much

Diane Lim
Vice President for Economic Research

Jobs and incomes are growing and inflation is still low.  The U.S. economy seems to be almost fully recovered from the “Great Recession” now, so Americans should be out there spending money again, right?  Well, Josh Mitchell of the Wall Street Journal points out (in a March 2 story) that gas price declines (and the resulting boost to the overall purchasing power of households) are not translating into the increased consumer demand economists would have expected.  Apparently people are “socking away” a lot of their “gas windfall” rather than spending it on other consumer goods and services.  The WSJ article cites this week’s Bureau of Economic Analysis (Commerce Department) release on personal income and outlays, which shows that while disposable personal income has been steadily increasing, personal consumption expenditures have actually fallen most recently.

Where is the extra money going?  To personal savings, whether in the form of growing positive balances in saving accounts or shrinking negative balances from paying down debt.  In Chapter 2 of the Economic Report of the President released late last month, President Obama’s economists highlight the massive “deleveraging” households have done since the “credit crisis” that precipitated the Great Recession.  From page 69 of the report we see that both liabilities-to-income ratios and debt service costs (required payments on the debt) as a share of income have fallen dramatically over the course of the current recovery.



A recent McKinsey report looking at global total debt (public plus private) highlights the sharp decline in the indebtedness of U.S. households as a significant factor in keeping U.S. total debt relatively stable compared with other countries, even as U.S. government debt has continued to grow.

U.S. households’ reduced “propensity to consume” (whether out of current earnings, savings, or debt) is one significant characteristic of our recovering economy which apparently makes the “new normal” different from the old, pre-recession normal.  An October 2014 Bureau of Labor Statistics report examines historical and projected trends in consumer spending and concludes (emphasis added):

With changing demographics, the impact of the 2007–2009 recession, and increasing global exchange and growth, some wonder if U.S. consumers will be an “engine” for economic growth in the future. Through 2022, BLS projects that the rise of consumer spending as a percent of nominal U.S. GDP will stabilize, and that consumer spending will grow at the same pace as the overall economy with slower growth than seen in the past.

So what’s going on?  Why the decline in America’s appetite for consumption?  Are we not the same “consumer-driven” economy we used to be? 

It does seem like the people coming out on the other side of the recession are “forever changed.” The American people now have different access to and attitudes toward consumption and debt, both because: (i) the circumstances and characteristics of the economy have changed, and (ii) because the cast of characters in the economy have changed.

The same old people have changed.  During the credit crisis of 2008 that precipitated the Great Recession, many households were forced to reduce their debt-financed spending because of lower limits and higher interest rates imposed on consumer credit lines (including home-equity lines) and mortgages. Many who weren’t forced to reduce their debt nevertheless chose to, motivated by their witnessing the far worse economic circumstances of others around them who may have lost their jobs, had their homes foreclosed upon, and/or declared bankruptcy.  A Federal Reserve Bank of New York report (2013) concludes that both tightened lending standards and “consumer-initiated” reductions in debt led to the deleveraging of the household sector, but admits that the data have limited ability to explain why households chose to reduce their debt.

There are new people now—different from the old people.  Much of the “new people” story refers to the incoming ”Millennials” (born 1982-2000)—who are not the same as their parents (many who are baby boomers) in terms of their goals and preferences regarding major life choices that affect the overall U.S. economy in profound ways—decisions about marriage/household formation, home and car ownership, and saving vs. buying more generally.  Millennials are choosing to marry later or not at all, hence setting up households and homes later.  Many are choosing to rent rather than buy housing, and to live in urban settings where owning a car isn’t necessary and can often be more hassle than it’s worth (especially with the availability of zip-car and Uber-type options).   And without the kind of home equity that their parents often borrowed against to finance consumption, these kids are less likely to end up in the same bad situation their parents did—where the equity disappeared (when the housing market crashed) while the debts remained.

Young people’s lower taste for housing consumption probably explains this other chart from the Economic Report of the President (page 73) and the fact that housing starts are not where economists would expect them at this stage in an economic recovery:



The Millennials will be a growing force in the U.S. economy over the next several decades.  As of last year, there were more 23 year olds—an age where careers are just getting started (and coincidentally my oldest daughter’s age)—than people of any other age.  Meanwhile, we baby boomer parents are going to pass into our retirement years and beyond and will be a dwindling influence on the economy (although we will certainly consume more health care services than others in our later years, and we still have to figure out how to pay for that).

Source:  “Marketers Are Sizing Up the Millennials,” by Dionne Searcey, New York Times, Aug. 21, 2014.

So, we shouldn’t expect the “new normal” of the U.S. economy to look like the “old normal” did in terms of consumer spending and household indebtedness.  But that means the economy will be much healthier and more sustainable post-recovery than it was pre-Great Recession—and that’s just another reason to embrace (economic) change.
 

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